This year investors learned that Chinese firms are defrauding investors through shortcuts and tricks that give the appearance of a highly profitable firm. Investors are becoming cautious and search for any news they can find concerning a company’s financial wherewithal.
One such firm is Harbin Electric Inc. (HRBN), based in Harbin, China. HRBN is a manufacturer of electric motors for different industrial sectors, including the transportation and energy industries, and is traded on the NASDAQ stock exchange.
HRBN announced that it is going private through a merger with Tech Full Electric Acquisition Inc. (TFEA), a company in the Cayman Islands that is wholly owned by Mr. Tianfu Yang, chairman and CEO of HRBN. TFEA will pay $24 per share in cash.
As of Dec. 31, 2010, Yang, as majority owner, held 30.83 percent of HRBN’s outstanding stock and according to investment analysts’ reports holds another 9.7 percent of the company’s stock indirectly. All insiders, directors, and executives held a combined 73.92 percent of the company’s outstanding stock.
“If completed, the merger will result in the Company becoming a privately-held company, and the Shares will no longer be listed on any public market,” HRBN said in its second quarterly Security and Exchange Commission (SEC) filing, filed on Aug. 9.
Putting pressure on shareholders, the company suggested in several press releases that shareholders vote “For” giving their approval of the proposed mergers.
Instead, shareholders filed complaints in Nevada (six actions in Nevada’s state court and two actions in Nevada’s federal district court) and New York courts (three actions), arguing that the offered share price does not present the true value of the company and is not in the best interest of shareholders.
“Plaintiffs allege, among other things, that the proposed buyout price and the process of evaluating the Proposal are unfair and inadequate,” according to the first quarter SEC filings.
On July 22, the U.S. District Court in Nevada ordered the dismissal of all pending motions by the shareholders, finding the $24 share price equitable, given that HRBN shares were trading much lower at $19.08 at the time.
On Aug. 19, the judge at the Suffolk County Supreme Court in New York ordered the dismissal of the shareholders’ complaint, citing that the court case should convene in Nevada, given that no “unjust or inequitable advantage” exists in the case, which was first filed in Nevada, and therefore would not require a remedy by a court in another jurisdiction.
On Oct. 10, the opposing parties reached an agreement by lowering the breakup fee from $22.5 million to $19.8 million, and HRBN agreed to be more transparent regarding its merger-related activities. The breakup fee is a fee that the seller must pay the buyer if the seller cancels the deal because it found another seller, or for any other reason.
“One key component of the settlement agreement was that the plaintiff’s attorneys wanted to be able to claim to the world (and to the court, when arguing for their fees) that they accomplished something for shareholders by bringing this litigation in the first place,” according to a recent article on the Seeking Alpha website.
Merger a Ruse
“The reason Citron believes SAIC [State Administration for Industry and Commerce in China] filings are relevant in the case of HRBN, is that the sources of funds for Harbin’s proposed going-private transaction are money from within China—whether it be a partner or a bank,” said Citron Research, a stock commentary website, in an online article.
Financial and other relevant documents submitted to the SEC are completely different from the ones provided to SAIC. According to the SAIC documents, HRBN reported losses in 2009 and 2010, while according to SEC documents, the company was rather profitable in both years. Then, HRBN significantly overstated liabilities (82.8 percent) in the SAIC filings and understated them in the SEC filings.
All merger-related components are in place, but everyone is dragging their feet?HRBN has procured $445 million from China Development Corp. There is already a signed contract with the buyer and lastly the timetable had been set, according to the second quarterly financial statements.
According to Citron, HRBN is hiding unstated liabilities and took advantage of a reverse merger to access capital in the financial markets. In reality, the company requires a large investment to make it palatable to investors, as all equipment and buildings are about 40 years old.
A reverse merger allows a company to access the U.S. exchange market within about 60 to 90 days after starting the process. A private company merges into a shell that is not an operating unit, but is publicly traded.
“Without the buyout offer, this stock could see single digits as investors realize they own a piece of China’s past, and not its future. As long as the CEO can continue to put out press releases of advisory committees and 8-K filings alluding to ‘wink wink’ conversations with analysts, the charade will continue,” Citron Research said.
Bird’s Eye View of HRBN
“The problem with HRBN (NASDAQ:HRBN) is not the short-sellers, as the company so vehemently stated on its last conference call. The problem is the company has been violating every principle of transparency,” Citron Research said in an August article.
HRBN’s SEC filings are silent on many business-related issues that generally are found in the filings by publicly traded companies. HRBN’s SEC filings lack transparency, and what is present somehow doesn’t ring true to a savvy investor, according to financial analysts.
Then, the Chinese regime forbids companies located in China to disclose detailed information about a company’s financial wherewithal, claiming that the country’s National Security and State Secrets Laws would be violated.
“Investors have nothing to judge an actual business, absent a buyout offer, except a 2010 audit by defunct auditor Frazer Frost, which was [sic] has become the poster child for auditor negligence in the Chinese RTO space,” Citron Research advises.
Frazer Frost, formerly known as Moore Stephens Wurth Frazer & Torbet LLP agreed, without admitting guilt, to be shut down by the SEC on Dec. 20, 2010, “for improper professional conduct in connection with annual audits and quarterly reviews of the financial statements,” according to an SEC findings report.
The SEC stated in its report that the “Respondents [Frazer Frost] did not exercise professional skepticism and due professional care, and Respondents otherwise violated professional standards.”
Searching for the Truth
“HRBN Electric cannot possibly pass an audit with a real accounting firm,” according to Citron Research.
On review of the Dec. 31, 2010, year-end consolidated financial statements, it appeared that HRBN increased its sales revenue by 48 percent over 2009 and it more than doubled (253 percent) since year 2008.
Investment and trading firms, including Citron Research, have researched the company and couldn’t independently confirm a single buyer that would account for the increase in sales.
HRBN named a few customers in its 2010 fiscal year-end financial statements, indicating Jiangsu Liyang Car Seat Adjuster Factory accounted for 10 percent of its annual sales revenue. During interviews with the company’s executives, the individuals stated that they do very little buying from HRBN, “a fact contradicting HRBN’s filings,” according to an article on Seeking Alpha.
